Time-varying performance of international mutual funds

Article history: Received 5 May 2010 Received in revised form 1 February 2012 Accepted 1 March 2012 Available online 8 March 2012 We examine the ability of oneand two-factor regime switching models to describe US, developed, and emerging market mutual fund returns. We find that a two-factor fixed transition probability model adequately describes the multivariate series of mutual fund returns without the need to model time-varying transition probabilities. Mutual fund performance, as measured by a state dependent Jensen's alpha, varies with economic regimes that are defined according to the global equity market mean. Our primary two-factor fixed transition probability model shows that emerging market mutual fund alphas are often significantly positive in global bull regimes. Consideration of alternative second risk factors suggests that both the foreign exchange factor, or the recently proposed Hou, Karolyi and Kho (2011) value factor can improve series forecasts and out-of-sample portfolio performance. © 2012 Elsevier B.V. All rights reserved.